When is borrowing at a low interest rate a bad thing for governments?

I was pleased to write an article for the Lowy Institute's great blog, The Interpreter, on Indonesia's regulation of toll roads entitled Indonesia's unorthodox toll road debt

From the article:

In 2016 Indonesia’s Ministry of Public Works dramatically underestimated the funds it needed to acquire land for toll road development. To try to keep development on schedule, the government leaned on toll road developers to lend them the difference at well-below-commercial rates. 

In the article, I try to set out how borrowing from the toll road developers at low interest rates may end up costing them more in the long run. To read more, head on over and have a read.

What the hell is going on in Nias between PLN and APR?

Last week APR Energy, a US-owned provider of electricity generation published the following open letter, indicating that they are intending to shutter their Nias plant, and pull out of the Indonesian market.

Source: APR Energy

Source: APR Energy

My (unofficial) translation of the letter follows:

Open Letter to the People of Nias

Dear citizens and business owners of Nias;

Since 2013, APR Energy has worked to give You electricity supply that can be relied upon.

Unfortunately, PLN has not yet paid our invoices. That company has not respected its contract with us. But PLN continues to collect money from the people of Nias for the electricity that they use.

As a result of PLN’s actions, we cannot continue our operation in Nias—or anywhere in Indonesia. At the end of May, we will permanently close our generator with total capacity of 20 MW.

Although we will leave, we would like to protect the people of Nias and ensure that you can still get electricity. Because of that, we have offered to sell our generator in Nias to PLN.

Unfortunately, PLN has not yet responded to our offer.

Please understand that our decision to leave Nias has not been easily undertaken. We regret the consequences that will occur with the closing of our generator. But we are also a business that has employees that work so that they can support their families. If we are not paid, we cannot pay our employees, and they are our most important responsibility.

Because PLN has refused to pay our invoice and to respect their obligations under their contract with us, APR Energy has no choice but to leave Nias at the end of May.

Our regards,

John Campion
Head and Chief Executive Officer

It is difficult to get a straight chronology of the dispute from the media, but all sources agree that it started with a dispute between PLN and APR Energy over their diesel generation facilities serving the city of Medan. The gossip around the market is that PLN requested a significant discount on its existing contract, and APR Energy refused to provide it, so PLN stopped paying them. Following this, APR Energy pulled their generators out of Medan, and warned PLN that they would do the same in Nias if their invoices were not paid by 31 March 2016.

Despite the warnings, by the deadline, PLN had not paid. So, at midnight on Friday 1 April 2016, APR Energy stopped generating, and the island of Nias--home to almost 800,000 people--went black. The estimates of the outage vary, Kompas reports that it was total blackout for at least 2 days after which time, they mobilised 17 separate generators, which would only meet 26 percent of the estimated peak load. Some other sites put the timeline at 12  or 13 days! I want to repeat again that this is an island home to 800,000 people!

Finally, the dispute was resolved, and PLN paid APR Energy’s bill after a mediation process where the US Ambassador was reported as getting involved. Although, according to the letter, which is undated, but which I first saw circulating on Whatsapp, then in Indonesian language media on the 18th of May, APR Energy is still pulling out of the Indonesian market.

Why this matters

The Indonesian government is currently making a big effort to improve its investment climate, vowing to improve Indonesia’s ranking in the World Bank’s Doing Business Index from 109 out of 189, to number 40 by 2017.

I have previously given PLN kudos for, among other things, their track record as a reasonable contractual counterpart. Looking from the outside, it difficult to assign fault in the dispute, but contractual disputes resulting in 800,000 people spending days in the dark, then the company packing up and leaving the market in frustration aren’t something you see when things are going smoothly. At the very least, the process was exceptionally poorly managed by PLN.

Whatever precipitated this, I hope the President’s office, Ministry of Trade, and PLN management take a good look at this case study to make sure that we don’t see too many more stories like this.

Here's the full letter banning Gojek, Uber, and others

Indonesian social media has exploded this morning with the news that Gojek, Uber, Grab Bike, Grab Car and all other app-based transportation services have been banned by order of the Minister of Transportation.

The implement of the supposed ban is surat pemberitahuan, or circular letter No. UM.3012/1/21/Phb/2015 sent to the head of the National Police, and copied to the Coordinating Minister for Politics, Law and Defence, the Coordinating Minister for Economic Affairs, all Governors of Indonesia, all regional heads of police, the head of the traffic corps of the National Police, the Director General for Land Transportation, and the Chairperson of ORGANDA.

Aktualita thoughtfully posted the full text, which I am reproducing here:

If you can't read Indonesian, in short, it says that the services named in paragraph one (Uber Taxi, Go-Jek, Go-Box, Grab Bike, Grab Car, Blu-Jek, Lady-Jek) are not in line with various laws and regulations governing traffic and road transportation. The letter asks the police to take steps in accordance with the laws.

Predictably, in the face of massive popular protest, and even personal intervention by the President, the Minister of Transport has clarified that all named services can keep operating, as reported by Detik.com

So, after one ill-conceived policy, Jakarta has had a morning full of sound and fury, ultimately signifying nothing. 

These sort of extreme policy backflips are regrettable, and don't do a lot to help build Indonesia's reputation as a stable place to do business... Hopefully we see less of these going forward.

If regulation of taxis and public transport interests you, I previously wrote about it here.

Indonesia Air Asia still in business

Whatever the problem Indonesia's transport ministry saw with Indonesia Air Asia's balance sheet, the Jakarta Globe reported yesterday that the government had given them an extension on their capital requirement and that now they need to comply by September 30.

This is good news. Although, perhaps "good news" is a bit of a strong term to use when the government avoids scoring an obvious own goal like this, we'll take what we can get.

Governments pay when they choose to renegotiate terms

I wrote yesterday about how the Indonesian government were handling a renegotiation of the terms of toll road concession contracts. 

As an example of how this works in countries with more mature regulatory regimes, this article talks about the Victorian government's decision to make trams free in the Melbourne CBD.

The government reported that they did it to help lower the cost of living, and to make it easier for commuters and tourists to use trams in the city. As the operator of the trams would be losing money as a result of this change, the Victorian government had the compensate them for the loss. The cost of the initiative was estimated at around AUD 100 million for the first year of operations.

Reasonable people can differ over whether making trams free is worth the money, or whether AUD 100 million is reasonable compensation for the loss, but the way the Victorian government handled the renegotiation was professional, transparent, and consistent with investor expectations, and good regulatory practice. 

A government like Victoria's knows that it's cheaper to pay AUD 100 million in cash than it is to run the risk of tarnishing their reputation with investors by trying to force the private operator to take the burden of their policy decision. Either way, they'll pay, at least this way they know exactly what it costs them.

All of this contributes to Victoria's perception as a low-risk investment destination, which flows through into cheaper goods and services for Victorian consumers.

Why exactly is Indonesia Air Asia at risk of being shut down?

Reports last week have indicated that AirAsia and 12 other airlines may be forced to shut down their Indonesia operations due to an interpretation of the regulations that says that their license may be revoked if they have negative equity. CNBC quotes Maybank-Kim Eng airline analyst, Mohsin Aziz, as describing it as a "black swan event", further stating the "no country in the world has ever done this."

The airlines affected include: Indonesia Air Asia, Cardig Air, Transwisata Prima Aviation, Eastindo Services, Survai Udara Penas, Air Pasifik Utama, Johnlin Air Transport, Asialink Cargo Airlines, Ersa Eastern Aviation, Tri-MG Intra Airlines, Nusantara Buana Air, Manunggal Air Service, and Batik Air.

The reporting on the matter indicates that the government's concerns with negative equity are safety-related. I don't see the direct link, but perhaps they think that if a company is unprofitable, it may be skimping on safety. Personally, I would rather that the regulator's efforts on enhancing safety are focused on the nuts and bolts, and standard operating procedures of the airlines. Leave the questions of solvency to the airlines' creditors and shareholders.

I'm not that familiar with the aviation law in question. I had quick look through it, but didn't see anything there that specifically dealt with negative equity. It might be some sort of indirect implication that being in negative equity might have. Perhaps something to do with foreign ownership restrictions*, but I'm just speculating here.

Does anyone have any theories as to what article of the law the 13 airlines are supposedly in breach of?

*Any air transportation business must have at least 51% of shares owned by a local shareholder under Indonesia's Negative Investment List.

Remedy period over, Kanci - Pejagan toll road is being repaired

In my maiden blog post, I wrote about how the MNC group had been called in default of their obligations under their concession agreement by Indonesia's Toll Road Regulatory Authority (BPJT) and had been given a 90 day rectification period. In the articles I linked to in that blog post, the MNC Group seemed to be trying to deflect blame for the poor condition of their road, even though, under their concession agreement, they alone are responsible.

Bisnis.com reports that the rectification period ended on the 17th of May and PT Semesta Marga Raya--the holding company for the road--seems to still be in control. Bisnis.com reports that the road surface is still not in great condition and that substantial works are ongoing, but the fact that they are still in control suggests that they have either met the minimum required standards for road quality, or they have convinced BPJT that they will do so within a reasonable timeframe. The President Director of PT MNC Infrastruktur Utama, Syafril Nasution, confirmed that works are ongoing and that they have spent IDR 80 billion on rehabilitation of the road so far.

I haven't seen a public record of what the MNC Group spent buying this toll road, but it was most likely something on the order of the IDR 2 trillion. If they hadn't foreseen this expense, they're looking at something like a 4% loss, even more if the IDR 80 billion doesn't include all the spending they will need to do to get the road up to standard. This is a pretty significant loss in the infrastructure business.

It seems like, in this case, BPJT has done their job well. They identified a problem and used the remedies available to them under the contract to force their concessionaire to solve the problem. I'm sure this is disappointing for the MNC Group, but this is how the infrastructure business is meant to work.

To me, this is an encouraging sign of Indonesia's growing maturity as a recipient of private investment in its infrastructure. BPJT, as the regulator, is establishing precedents for how it acts in holding concessionaires responsible for their obligations under their concession agreements*. A consistent track record of fair and balanced regulatory judgments is a very valuable thing in attracting the kind of infrastructure investors Indonesia wants when it finally gets around to tendering the next round of PPP toll road projects.

*Of course, we need to look at how BPJT acts in situations where the penalties or benefits are in the concessionaire's favour too. I hope they are as quick to enforce the contract in those instances!

Jakarta taxis need peak pricing

I took a Kopaja bus from Polda Metro to Blok M during rush hour the other day because it was starting to rain and I couldn't find a cab. I got to Blok M and wandered over to SMAN 6, where taxi drivers often hang out. Like usual, there were 5-6 taxis parked there, all from good companies, but all seemed like they were eating or sleeping, so I wandered a bit further. 

As I walked, two available Blue Bird taxis drove past me before one stopped. He said he was actually on his way to take a rest, but he'd take me because I was close. 

I was confused: why would taxis be choosing to rest during peak times? Surely that's when it's easiest to get a passenger. 

The taxi driver said, yes, it is easiest to get a passenger during peak times, but you have to sit in traffic longer to get to them, the meter runs slow because of the heavy traffic, and, if you get someone that takes you to a really out of the way place, you can get stuck in traffic trying to get back to a place where you can get your next passenger.  In this sort of situation, as a taxi driver, you're better off waiting out the peak, and jumping back in your cab when the traffic dies down.  

If you work in Jakarta, you're familiar with the queues for taxis at peak times. At certain buildings like the Stock Exchange Building or Sampoerna Strategic Square, an hour's queue at 6pm is pretty standard, two hours is not unheard of. 

The taxi queue times have negative impacts on society. Massive amounts of time is wasted that citizens could put to better use, and some people will choose to buy private cars further adding to congestion. On the plus side, some people will choose to take buses, but the length of the taxi queues suggests that there's a significant population that won't*. 

Peak pricing, or allowing taxis to charge more during peak times, would have two major positive impacts. First, it would encourage drivers that currently sit out the peak to come back on to the road. Secondly, as drivers and taxi companies would be making more money, they would be willing to put even more taxis on the road. Both of these things would decrease queuing times, making riding a taxi relatively more attractive compared to private cars.

On the negative side, there would be people that wouldn't be able to afford the higher tariff, but those people could still ride buses, or choose to travel before or after the peak times.  

So, if all these good things follow from peak pricing, why haven't we got it already? My guess would be that it's because companies are scared to be the first one to do it. It might be more economically efficient, but it's usually not popular among your customers. Being the first company to do it would most likely mean you would lose customers to your competition.

It's also unclear what the provincial government of DKI Jakarta would have to say about this. My understanding of taxi fare regulation is that it is governed by Perda 12/2003, pasal 77 of which says that taxi companies are allowed to set their own tariffs, but they must be approved by the Governor**. It's not impossible that if a taxi company did try to implement peak pricing, someone within the Jakarta government might think they could score political points by opposing it. 

As I said earlier, I think there are benefits to broader society from peak pricing that would accrue in the form of less congestion. Unlike shorter waiting times for customers, and higher profits to the taxi companies, the lower congestion is a positive externality that accrues to society from these two parties undertaking the transaction. 

On the basis of this externality, I think there's a role for DKI to not just not oppose peak pricing, but to encourage taxi companies to take it up. If DKI Jakarta were to publicly encourage taxi companies to adopt peak pricing and to talk about the broader benefits to society, citizens would be less likely to react poorly. 

I, for one, hope they do soon!

*I've actually been in both the populations that buy cars in response to taxi queues and those that ride buses. I would be using my private car now, except for my own peak demand problem, where my wife and daughter want to use the car in the morning and evening. Lowest value users get sidelined... Buses and taxis for me. 

**Note that this is the same regulation under which various people are complaining that Uber is illegal, because it is charging "illegal" tariffs that haven't been approved by the governor.

Do the MNC Group not understand the infrastructure business, or do they understand it too well?

The MNC Group is one of Indonesia's largest media conglomerates. In 2013, they moved into infrastructure by, among other things, purchasing a few toll roads from the Bakrie Group. Over the past few weeks they seem to have been getting in trouble with their Kanci - Pejagan toll roads, and the comments they have been making in the media have been more than a little worrying for people that work in the field of infrastructure regulation.

The week before last, Detik Finance published two articles titled "Bakrie and MNC have been in default on the Kanci-Pejagan Toll Road" and "MNC: The Kanci-Pejagan Toll Road has been broken since we bought it from the Bakries."

The first article claims they are not meeting the minimum service standards and that they need to fix the toll road at their own cost, or try and sell it to someone who will. According to the head of Indonesia's Toll Road Regulatory Authority (BPJT), Achmad Gani Ghazali, they've got 90 days to rectify, of which about half has elapsed.

In the second article, the President Director of the operating company, PT Semesta Marga Raya, Irmawanto Soekamto, is quoted as saying "The tollway was in really bad condition when we received it. From the beginning, the tollway has had continual repair work conducted on it", and "we have been asking ourselves, the construction of this road should last decades, but why, as soon as we receive it, is it in such bad condition?"

In addition to blaming the Bakries, Detik's article also notes that Indonesian state-owned contractor PT Adhi Karya (Persero) constructed the road and that it was opened by former President Susilo Bambang Yudhoyono.

The article further notes that the concessionaire asks for forbearance from their users and that they are pursuing legal action to determine the cause of the poor road condition. It closes with a quote from Irmawanto: "I am certain, truth will come out. We all know that this toll road was heavily damaged from the start. So we just need to wait and see who is truly responsible for all of this damage."

I don't know who was responsible for the damage that has led to the current poor quality of the road, but I can tell you who is responsible for fixing it now: the MNC group as current concessionaire.

A CA, like any agreement, governs rights and responsibilities of the parties. In toll roads, the government concedes to allow a private party to charge a toll for the use of the road, but in return, they must build and maintain the road such that it meets the specified minimum standards. In Indonesia, there are only two parties to a toll road CA, the government and the concessionaire. As such, the only two parties with any rights or responsibilities under the CA are the government and the concessionaire.

As the MNC group currently own the operating company, then even if Adhi Karya built a poor quality road, and the Bakries maintained it badly, the users and the government should not care. As the current concessionaire, the MNC group alone have the responsibility to ensure the road is in good order and they alone must bear the cost of doing so.

It is possible that the MNC group can sue either the Bakries or Adhi Karya to recover or defray some of the cost of repairing the road and, if so, I wish them the best of luck in their endeavour, but I have never seen a clause in an Indonesian CA that allows the concessionaire to breach its minimum service standards while it has a fight with some other party. In fact, most CAs in all jurisdictions specifically note that the concessionaire is solely responsible sub-contractor non-performance, and that any change in ownership must be conducted in such a way as to ensure the continued fulfillment of the minimum service standards.

When MNC bought the toll road, they would have run a financial model projecting out all of the revenues they expect to get over the remaining life of the concession, and the costs they would incur in keeping their asset in the required condition to figure out how much they would be willing to pay for the asset. Their projected costs should have included, of course, any rehabilitation required to bring the road up to the required minimum standard.

If MNC did not accurately project the costs or rehabilitation or ongoing maintenance, or didn't read the CA to understand their minimum standards, then, quite frankly, they should lose money... They're a serious company paying serious money taking on some serious obligations. If they're not going to take it seriously, then they shouldn't be in this business.

This idea that a sub-contractor or previous owner non-performance is not the government's problem is not some arcane point of theory, this is beginner stuff. In giving an interview like the one Irmawanto gave to Detik, it seems like one of two scenarios is possible:

  1. MNC don't understand the simplest things about infrastructure investing
  2. MNC think that the government does not understand the simplest things about infrastructure regulation.

Unfortunately, private businesses making money by betting on the second scenario has some precedent, not just in Indonesia, but all over the world. When we get private contractors to invest in and operate our infrastructure, we want them to innovate on lowering cost, or raising revenue, but sometimes they choose to innovate in trying to renegotiate contracts or otherwise weasel out of their obligations. 

The reality is, especially in developing countries, regulators often don't understand contracts that well, and private companies can usually afford much more expensive and intimidating lawyers than the government can, so even a really well-designed contract* can result in a bad outcome.

CAs often have a clause that allows for the concessionaire to get compensation in the event that the government asks them to do something that might cause them to incur extra costs. Examples of reasonable requests a government might make that a concessionaire could reasonably request compensation for might include widening a road, changing the weight limit of a bridge, installing flood mitigation measures following a new national standard and so on. The concessionaire's compensation for the government's request could be cash, relief of paying a concession fee, an increase in tariff, an extension of the concession period, or something similar. MNC may be hoping that they can convince the government that this rehabilitation expense should be considered a government request that causes them to incur extra costs, rather than something that arose as a result of their own negligence.

In my experience, I have found BPJT to be staffed with pretty professional operators that wouldn't fall for things like this, but then, MNC have a reasonable track record of success in investments that indicate that they know what they are doing.

I don't know which of my scenarios accurately describes MNC's thinking, but I hope they're spending more on maintenance and rehabilitation than they are on their legal fight... Either way, they've only got half of their 90 day rectification period left, so we'll find out soon enough...

Note: all quotes are translated by the author, for the original wording, please refer to the linked articles.

*The regulatory capacity of the government is a critical thing to take into account when designing a contract, and aligning the regulatory responsibility with their capacity decreases your chances of getting a bad outcome.